It is important to note that the disastrous results reflect past decisions much more than present ones. They are a legacy of Lula’s second administration, and Dilma’s presidency, which will continue weighing on future presidents. The economy reacts to changes in economic policy slowly. Monetary policy takes two quarters to produce clear effects on activity, and fiscal policy takes twice as long. The main reasons for the economic contraction in 2016 were the fiscal crisis and the necessary monetary tightening in 2015, which had to be maintained for most of last year.
But 2016 was an important year regarding correction of economic policy bearings – despite mistakes, such as the pay rise for civil servants in the midst of the worst unemployment crisis in the country’s recent history – and establishment of a structural agenda, though still incomplete.
That said, 2017 promises to be a year of transition, not merely a continuation of 2016. It will not necessarily bear much fruit, in part because some planting is still being done, such as the social security reforms and measures to address the states’ fiscal crises. Besides this, the economy has its cycles. It takes time for the labour and credit markets to complete their adjustments, and for the monetary relaxation to reach a sufficient magnitude do spur activity.
These cycles should reach their turning points somewhere in the middle of the year. This is a modest scenario. Depending on the final figure for 2016, GDP will unlikely grow by more than 0.5%. It is true that the country has not reached sufficient maturity for more robust potential GDP growth (it is around 1.5%), mainly with the legacy of mistaken fiscal policy and government interventionism in recent years, whose correction will not be quick. Nevertheless, given the gravity of the crisis, the cyclical return of growth is welcome, and can contribute to a less tumultuous political picture, including in 2018.
This scenario presupposes not only sufficient room for the Central Bank to relax monetary policy, but also approval of a meaningful social security reform package and good progress made by state governments in resolving their fiscal crises.
In monetary policy, assuming the neutral real interest rate is around 5% (estimate of XP Gestão), there is room to cut the SELIC rate by one digit, since inflationary expectations are anchored. This would mean normalisation of monetary conditions.
Regarding social security reform, though it will face opposition from some segments of society, the discourse on fiscal rigor is increasingly spreading, as can be seen by the policy ideas espoused by mayors-elect. This will increase the chances of approval of the reform proposals.
The state crises are a main source of risk, and recent decisions by Congress and the Supreme Court are serious aggravating factors. Congress rejected the imposition of counterpart commitments by state governments in renegotiating their debts to the federal government, prompting Temer to veto part of the bill, while the Supreme Court opened room for a new dispute between the federal and state governments regarding the Kandir Law (which exempts exports from state value-added tax), something that can contaminate the bargaining process over counterpart commitments in debt renegotiations. This could give state governments an excuse to delay the necessary structural fiscal reforms. That aside, Justice Carmem Lúcia issued an injunction preventing the federal government from blocking funds of the state of Rio de Janeiro due to a loan default by the state, which led the federal government to execute the counterpart guarantees. This opened a precedent that weakens the system of federal guarantees on state loans.
Cautious optimism is important and the risk of accidents along the way, including political risks and their consequences on the economy, are very real. With the economy still very fragile and credit tight, there is a risk the crisis still has room to worsen, with further increases in unemployment. In short, there is a risk the economy will deteriorate a bit more before improving.
It is sensible to be hopeful about the external environment. After two years of global deceleration, there are signs that the international economy is gaining steam again, with a positive impact on commodity prices. Among emerging countries, the feeling that “the worst is over” could grow, favouring the performance of the advanced economies. It is thus reasonable to expect some reaction from world trade, currently stagnant. The more favourable dynamics of the global economy at the margin will not necessarily offset the geopolitical risks and greater experimentation, notably in the USA. But it can be an important ingredient to attenuate the effect of these shocks.
The risks are significant, which prevents forecasting a high probability of an optimistic scenario in 2017. But it is also too soon to envision that this year will be “more or the same.” There is reason for hope: 2016 was not in vain, but the work has not ended, and 2017 will be a crucial sequel.
